October 26, 2008

Urgent need for IMF action

Paul Krugman frets that we are about to witness the mother of all currency crises in emerging markets, and I am afraid that he is right. As I wrote in my previous post, the financial crisis in the developing world has just started and there are indications that it will get a lot, a lot worse. What is different with this phase of the crisis is that it cannot be addressed by governments in the affected countries issuing their own fiscal guarantees and domestic currency. These countries need external lines of credit, and they need it fast before the scale of the problem becomes truly unmanageable.

The solution is clear. The IMF, possibly along with central banks of the G7, has to act as a global lender of last resort to emerging markets. These countries have to have ample access to liquidity in reserve currencies--quickly and with few strings attached--for them to be able to fend off what may otherwise become a historic rout of their currencies. And China should join in: it should make a portion of its near-$2 trillion of reserves available in support of this global enlargement of credit lines.

Emerging markets have every right to say that they are being swept under by a crisis that is not their own doing. But the real reason the rest of the world needs to move on this front is naked self-interest. Combine a deep recession in the advanced countries with an uncontrolled depreciation of emerging-market currencies, and the pressure to erect trade barriers in the U.S. and Europe will be impossible to withstand. A vicious cycle of unemployment and protectionism feeding on each other a la 1930s could transform the deep recession everyone is already expecting into a second great depression. It can get worse...

And with this bit of good news just in, Dominique Strauss-Kahn should have no distractions to prevent him from focusing on this most urgent task. There are some reports that the IMF is moving in this direction. I have a feeling that this will be the make-it-or-break-it week for emerging markets. I hope the IMF will make an announcement in time to make a difference.

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As you say, the impact on emerging markets, and on developing countries, are just beginning to unfold.

Ngaire Woods and David Roodman discuss the implications for developing countries in the latest edition of the development drums podcast(http://developmentdrums.org) and their conclusion is not optimistic.

I think there is a good chance that we will (through the IMF) provide some help to emerging economies, precisely because, as you say, it is in our interests to do so.

But for the least developed countries: does anyone in the industrialised world care enough? Having made promises to provide aid to countries that put themselves on the path to growth and reform, we seem to be about to renege on our promises.

This whole crisis is reminding me of 1982. I wasn't around then but my reading of it makes it seem somewhat similar (in terms of effect not cause), especially as commodity prices look like they are crashing. I'd like to hear what you think about this situation compared to past crises and the role the IMF is playing now as compared to then. Of course it now looks like countries are desperately trying to avoid the IMF.

I am a Turkish engineering PHD student following the global financial roller coaster -which looks to be on a suicide mission as the events unravel- and trying to make a sense of it.

So far the response of the Turkish government has been, "Don't worry, our banking system was fixed in 2000" and "We got enough foreign currency."

However, after reading Professor Krugman's article today on the lurking currency crisis, my suspicion on the truth value of those statements grew. Especially this part seemed to reflect my understanding of the Turkish economy:

"In Russia, for example, banks and corporations rushed to borrow abroad, because dollar interest rates were lower than ruble rates. So while the Russian government was accumulating an impressive hoard of foreign exchange, Russian corporations and banks were running up equally impressive foreign debts."

You are saying:

"These countries need external lines of credit, and they need it fast before the scale of the problem becomes truly unmanageable."

Which comes a day after the head of the central bank and the government commented negatively on a deal with IMF.

wait why is that a piece of good news? Now that he is bailed out, there will be moral hazard problem the next time an old IMF officer is alone with any young female officer there. If we let them off easily, then in the future, the old officer might be willing to partake in risky acts.

1.- Extend swap lines to all main emerging markets.
2.- Have IMF extend low-conditionality loans to all countries that request it.
3.- Discourage big banks from withdrawing credit lines from overseas operations.
4.- China, Japan, and North Korea should undertake a coordinated macroeconomic expansion.
5.- Middle East needs to recycle all their cash. (Note the cash is already deposited, somehow ,somewhere)
6.- US and Europe should expand exports credits for low and middle income countries.
7.- US and Europe should follow an expansionary fiscal policy.

We do that and according to Sachs “At the least it would put a floor on the global contraction that is rapidly gaining strenght.

But even if we would accept Sachs very optimistic view on the fiscal capacity of these countries as true, we should ask whether this is wasting aspirins or throwing real medicine at the problems? On the same page in FT Michael Skapinker, recounts in “An ethics lesson from an unlikely quarter” what Wal-Mart is doing to enforce ´sustainability, demanding “rigorous environmental and social standards”.

The big question becomes then, should we now pull out all the stops in order to regain equilibrium on what might be a path to unsustainability as Sachs suggests or should we use this crucially decisive moment to provide the incentives to explore other perhaps more sustainable routes?

In the panic it is still wise to take a brief time-out and think about what door to use. In fact our world at large is not only looking for an escape door for a financial crisis, it is looking for a door that can lead it to a better place.

But, of course, we do not have all the time to make up our minds… it is burning out there.

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